Recently, the National Company Law Tribunal
("NCLT") refused to sanction a scheme of
amalgamation between Ajanta Pharma Limited
("AJL") and Gabs Investment Private
Limited ("GIPL") on the ground that the
scheme was designed purely for the avoidance of tax and was not in
the public interest.

Background

AJL is a listed Indian pharmaceutical company. GIPL is an
investment holding company owned and controlled by the promoters of
AJL. GIPL held 83,92,262 equity shares of AJL constituting 9.53% of
AJLs total paid up equity share capital. The total promoter
shareholding in AJL is set out in the diagram below.

The merger of GIPL with AJL was approved almost unanimously by
the shareholders of both companies on October 10, 2017. As a
consequence of the merger, GIPLs shareholding in AJL would be
extinguished. Similarly, the promoters' shareholding in GIPL
would be extinguished, in consideration for which, AJL would issue
83,92,262 fully paid up equity shares to the promoter shareholders
of GIPL. As a result, while the total promoter shareholding in AJL
would remain the same, the shareholding of the individual promoters
would increase. The merger, its consequences and the post
shareholding pattern of AJL are illustrated in the diagrams
below.

Following recent amendments to the Companies Act, 2013, notice
of any scheme of amalgamation is required to be given to sectoral
regulators and authorities that are likely to be affected by the
scheme. The regulators are allowed a statutory period of 30 days to
make representations to the NCLT with respect to the proposed
scheme following which, they are deemed to have no such
representations to make.1

In the instant case, the Indian tax authorities objected to the
merger.

Objections of the Indian Tax Authorities

The central objection of the tax authorities was that GIPL,
being a separate legal entity, was only entitled to distribute its
assets to its shareholders by way of a taxable transfer or a
dividend distribution. In the case of the former, the tax
authorities argued that the gains arising on the transfer would be
subject to tax at the rate of approx. 30%2, while in the
case of the latter, the amounts distributed would be subject to
take at the rate of approx. 20%.3

The tax authorities contended that by allowing the merger of
GIPL into AJL (which would likely have qualified for tax neutrality
under the provisions of the Income Tax Act, 1961
("ITA"), GIPL would in
effect4 be transferring its shareholding in AJL to the
promoter shareholders tax free. The tax authorities therefore
determined that in view of the General Anti Avoidance Rule
("GAAR"), the merger was a deliberate
measure to avoid tax and would constitute an impermissible
avoidance arrangement and should therefore not be sanctioned by the
NCLT.

NCLT's Ruling

Recording that if the merger were to be sanctioned, the promoter
shareholders of GIPL would receive shares of AJL without paying any
income tax, which would not be in the public interest, the NCLT
refused to sanction the merger. Finding merit in the objections
raised by the Indian tax authorities, the NCLT was of the opinion
that issues relating to tax should be settled prior to the scheme
being sanctioned, instead of at a later stage after the scheme is
sanctioned.

Analysis

The NCLT's refusal to sanction the scheme continues a trend
established in the case of Wiki Kids Limited and another v.
Regional Director and Other5, wherein the
National Company Law Appellate Tribunal
("NCLAT") refused to accord to sanction
to a scheme of amalgamation it assessed as being purely for the
benefit of the promoters and no public interest was being
served.

In this case, the NCLT arrived at the conclusion that the scheme
was not in the public interest primarily because it was designed to
avoid payment of tax on the transfer shares of AJL from GIPL to
GIPLs shareholders. While the Tribunal did not expressly label the
scheme an impermissible avoidance transaction, that would therefore
fall foul of the GAAR, it is clear that it accorded significant
credence to the Indian tax authorities assertion that the scheme
was such. The decision of the NCLT is cause for concern.

Firstly, it is unclear whether sufficient analysis has been
undertaken to determine whether the merger would in fact amount to
an impermissible avoidance arrangement. An 'impermissible
avoidance arrangement' is an arrangement entered into with the
main purpose of obtaining a tax benefit and satisfying one or more
of the following: (a) non-arm's length dealings; (b) misuse or
abuse of the provisions of the domestic income tax provisions; (c)
lack of commercial substance; and (d) arrangement similar to that
employed for non-bona fide purposes. While the tax authorities
argued that the main purpose of the merger was to avoid tax (i.e.,
obtain a tax benefit), the NCLT did not consider whether simply
claiming an exemption from capital gains tax made available under
ITA expressly for such mergers would amount to avoidance of
tax.6 The NCLT also did not conclude that any of the
tainted element tests had been met. To the contrary, the prima
facie the merger appears to be bona fide, GIPL was incorporated in
1995, and has held shares in AJL since 2008. It likely was
incorporated for legitimate commercial considerations, and in the
absence of any evidence to the contrary, its merger into AJL (duly
supported by commercial rationale set out in the scheme of
amalgamation filed before the NCLT) should not have been viewed as
a colourable advice or impermissible avoidance agreement.

The CBDT had also clarified that the GAAR will not interfere
with a taxpayer's right to select or choose a method of
implementing a transaction. In the instant case, the promoter
shareholder of GIPL could have achieved a direct shareholding in
AJL in a number of ways, including by way of the merger, a dividend
distribution or a simpliciter share transfer. While it is true that
the merger was likely the most tax efficient way to achieve a
direct shareholding, the NCLT appears to have ignored that settled
jurisprudence that "simply because the tax payable under
the business structure adopted by the assessee, which he is
otherwise entitled to adopt in law, is reduced, does not . . . make
such adoption illegal or impermissible on the ground that it is
opposed to public interest."7

In fact, the Supreme Court of India has held, in the landmark
case of Miheer H Mafatlal v. Mafatlal Industries Limited,
that it is not the role of the court to "act as a court of
appeal and sit in judgment over the informed view of the concerned
parties to the compromise as the same would be in the realm of
corporate and commercial wisdom of the concerned parties. The court
has neither the expertise nor the jurisdiction to delve deep in to
the commercial wisdom exercised by the creditors and members of the
company who have ratified the scheme by the requisite
majority.....The Court acts as an umpire in a game of cricket to
see that both the teams play their game according to the rules and
do not overstep the limits. But subject to that how best the game
is to be played is left to the players and not the
umpire".

Also, in Union Bank of India Ltd. v. United India Credit
& Development Co. Ltd.8, the Calcutta High
Court held that "where there are several legitimate
alternatives, means and procedure for attaining the same object,
there is no bar in choosing any one of them, according to the views
of the directors and the shareholders of a particular
company".

The ITA expressly exempts certain qualifying mergers. The
exemption recognizes the principle that in a qualifying merger,
there is no economic gain that is made available to the ultimate
owners of the merging entity. Economic ownership of the merged
assets generally continues to vest in the ultimate owners, albeit
through shares in the remaining entity.9

Further, in Circular No.7 of 2017 the Central Board of Direct
Taxes ("CBDT") had clarified that a
proposal to declare an arrangement an "impermissible avoidance
arrangement" under GAAR would be vetted first by the Principal
Commissioner and at the second stage by an Approving Panel headed
by a judge of a High Court. It is unclear that such procedure was
followed in the instant case.

It is therefore a cause for concern that in the absence of any
illegality in the merger scheme, the NCLT refused to accord its
sanction on the basis of mere allegations that the transaction
would run afoul of the GAAR. Even if that were to be the case,
there is no bar on the tax authorities (in fact the tax authorities
have been empowered) to disregard and recharacterize the merger for
tax purposes.

This ruling reinforces the need for merger schemes to be vetted
thoroughly from a GAAR perspective. The fact that a routine merger
can also be blocked simply by the threat of the GAAR is also
unlikely to aid the ease of doing business in India.

Footnotes

1 Section 230 of the Companies Act, 2013

2 The tax authorities presumed that the gains should be
treated as business income, as opposed to capital gains, since one
of the business objectives of GIPL, as per its memorandum of
association is investing and dealing in equity shares. This is a
rebuttable presumption but the NCLT did not delve into this aspect
further.

3 It is unclear from the ruling whether the tax
authorities envisaged a dividend distribution in specie, or a sale
of AJL shares followed by a dividend distribution of the sale
proceeds. In the former, DDT would only be payable to the extent of
GIPL's accumulated profits.

4 Legally speaking, GIPLs shares in AJL would stand
extinguished, and fresh shares of GIPL would be issued to the
promoter shareholders (in consideration for the extinguishment of
their shares in GIPL).

5 Company Appeal (AT) No.285 of 2017

6 In fact, the Final Report of the Shome Committee on the
GAAR concludes that the timing or sequencing of an activity is a
business choice available to the taxpayer. GAAR cannot be invoked
when taxpayer makes a choice about timing or sequencing of an
activity to deny a tax benefit granted by the statute.

7 Vodafone Essar Mobile Services, [2011] 107 SCL 51
(Del HC)

8 [1977] 47 Comp.Cas. 689 (Cal).

9 Where it does not, and ownership is exchanged for cash
consideration, the exemption falls away.

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guide to the subject matter. Specialist advice should be sought
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The Chennai Bench of the Income Tax Appellate Tribunal in a recent ruling in Dr. Muthian Sivathanu v Assistant Commissioner of Income-tax [ITA No. 553/2018] held that proceeds received on sale of shares ...

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